401(k) Law Suppresses
Saving for Retirement

A 2006 law designed to boost employees' retirement-savings is having the opposite effect for some people.

WSJ's Anne Tergesen reports a 2006 law allowing companies to automatically enroll people in 401(k) plans has had unintended consequences. AP Photo/Ron Edmonds.

Under the law, companies are allowed to automatically enroll workers in their 401(k) plans, rather than require employees to sign up on their own. The measure was intended to encourage more people to bulk up their retirement nest eggs—a key goal in a country where millions of people aren't saving enough.

But an analysis done for The Wall Street Journal shows about 40% of new hires at companies with automatic enrollments are socking away less money than they would if left to enroll voluntarily, the Employee Benefit Research Institute found. The nonprofit performed a complex computer simulation of savings patterns drawing on data from more than 20 million 401(k) participants.

The problem: More than two-thirds of companies set contribution rates at 3% of salary or less, unless an employee chooses otherwise. That's far below the 5% to 10% rates participants typically elect when left to their own devices, the researchers said.

"Automatic enrollment is a double-edged sword," said Brigitte Madrian, a professor at Harvard University who is an expert on 401(k)s. "On the one hand, there's more participation. On the other hand, lots of employees are stuck at whatever default the employer selects."

The total annual amount being put into 401(k) plans has increased by 13% since 2006, to an estimated $284.5 billion this year, according to consulting firm Cerulli Associates. That is largely because the rule has successfully prodded millions of people who wouldn't have saved a penny for retirement to start saving something.

But for the 40% of new workers who would have picked a higher savings rate than the company assigned to them, billions of dollars in potential retirement savings will be left on the table, said Pamela Hess, director of retirement research at Aon Hewitt. The human-resources consulting and outsourcing company serves as a record-keeper for $296.8 billion in 401(k) plans.

ENLARGE

EBRI evaluated the contribution rates of people of similar ages and salary levels eligible for 401(k) plans with automatic enrollment versus those in plans that require workers to join voluntarily, examining data stretching back 11 years. To project future savings patterns among auto-enrolled participants, EBRI ran a computer simulation based on a variety of scenarios concerning wage growth and the adoption of higher contribution rates over time.

Simple inertia takes over for many workers, said Kristi Mitchem, head of the global defined-contribution business at State Street Global Advisors, which manages more than $166 billion in 401(k) plans.

When Joe Osborne, 25 years old, joined E*Trade Financial Corp. as a senior specialist in corporate communications in April, he was auto-enrolled at 3% of pay. Although he said he plans to increase his contribution rate, he has yet to do so. "I'm still adjusting to my budget," he said.

A spokeswoman for E*Trade said the financial-services company went with 3% because "if you start the rate too high, the chances of employees opting out are higher."

From SmartMoney

Some auto-enrollment programs have "auto-escalation" features that increase employee savings rates by a set amount, typically one percentage point a year, until they reach a certain threshold. Even this might not be enough: An October study by EBRI and the Defined Contribution Institutional Investment Association found that, depending on their incomes, 54% to 73% of employees would fall short of amassing enough money to retire if they enrolled in their companies' 401(k) plans at the default-contribution rate and were auto-escalated by 1% a year to a maximum of 6%.

The Pension Protection Act of 2006, which was designed to shore up the pension system, also encouraged wider adoption of auto-enrollment in 401(k) plans. It removed obstacles such as state laws that restricted the practice and shielded employers who use certain types of investments from liability for losses suffered by participants who are auto-enrolled.

The law has boosted auto-enrollment and participation rates dramatically. About 57% of large companies now automatically enroll new employees in 401(k) plans, up from 24% in 2006, according to Aon Hewitt. While employees are free to opt out, companies report average participation rates above 85%, compared with 67% for those without auto-enrollment, Aon Hewitt says.

Yet 401(k) participants' average savings rates have fallen in recent years. Among plans Aon Hewitt administers, the average contribution rate declined to 7.3% in 2010, from 7.9% in 2006. The Vanguard Group Inc. says average contribution rates at its plans fell to 6.8% in 2010, from 7.3% in 2006. Over the same period, the average for Fidelity Investments' defined contribution plans decreased to 8.2%, from 8.9%.

Vanguard estimates about half the decline "was attributable to increased adoption of auto-enrollment."

David Navari, 45, was auto-enrolled at 3% when he joined Computer Sciences Corp. as a consultant in October 2008. Although the Takoma Park, Md., resident said he maxed out his contributions to previous employers' retirement savings plans, he stuck with 3% during his two years at CSC. The extra cash was helpful in meeting private-school tuition bills, he said.

CSC said it "offers auto-enrollment and auto-escalation to simplify the enrollment process, by helping busy employees save for their future with significant tax advantages during their working years."

Many companies said they selected a 3% default contribution rate in part out of concern that a higher rate could prompt employees to drop out of these plans.Medtronic Inc. spokeswoman Cindy Resman said the medical-device maker opted for a 3% contribution rate because that was the prevailing rate in 2007, when the company implemented auto-enrollment.

Another factor may be pushing down default rates: Some companies that match some employee contributions can save money with a lower default rate. According to a 2011 Aon Hewitt survey, 73% of employers without auto-enrollment cite "the increased cost of the employer match as a primary barrier" to adopting it this year.

Over time, many employees raise their contribution rates. Still, 15% to 25% of workers eligible for 401(k) plans with auto-enrollment are unlikely ever to catch up to the annual contribution rates they would have chosen under plans with voluntary enrollment, estimates Jack VanDerhei, the EBRI's research director.

Consultants say some companies assume regulators intended to steer companies to a 3% default contribution rate, because that was the example the IRS used in its initial automatic-enrollment regulations issued in 1998. Regulators are trying to make it clear that companies are free to raise their default contribution rates. Mark Iwry, a deputy assistant secretary at the Treasury Department, said the agency has issued guidance to state that companies "are not limited to an initial 3% deferral rate."

"What we have hoped all along is that employers and employees would get comfortable with higher levels of automatic contribution," he said.

Corrections & Amplifications Street Global Advisors manages $166 billion in 401(k) plans. An earlier version of this article incorrectly said the company manages more than $297 billion in 401(k) plans.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.